Natural gas, on tap or bottled

Where does natural gas fit in China's energy future?
The fundamentals for natural gas almost everywhere in the world look extremely good for at least two reasons. One is that using gas for generating electricity has enormous advantages because in most electricity power markets the capital costs of building gas-fired plants are much lower than the alternatives, and that's very attractive to investors and good for consumers.

The second reason is that the environmental qualities are favored over the alternatives, notably coal, because gas has essentially no particulate emissions or sulphur emissions. It's almost an intrinsically clean fuel.

The situation in China is a little different, but still the fundamentals look pretty good for gas. What's different about China is that the capital costs of building coal-firing electricity plants is surprisingly low by world standards and so the combination of the lower capital costs and the fact that coal is still cheaper in China than natural gas means that just looking at the margin – that coal is still the winner over natural gas.

But that's not the way the parts of China that are introducing natural gas are thinking about the problem. We see in Guangdong power plants being built to use gas that's going to come in by tanker at the LNG terminal at Shenzhen, the terminal BP is building with several partners including Towngas in Hong Kong. It's just been in the news that in Beijing gas supply is now out to the fourth ring road and that's gas that's not even being used mainly for electric power generation, but for heating and industrial processes. So even considering the pure economics where gas has a hard time competing with coal, you're seeing a really dramatic introduction of natural gas into the Chinese economy. I think a lot of that has to do with the environmental benefits of gas.

The environmental differences seem substantial, but what are the cost differences between gas and coal?
It depends on the markets and what you think of the price of coal in different places. Two years ago, my sense was the difference between gas-fired and coal-fired electricity was pretty substantial: 20% or more, and much more in some settings. Today, because coal prices have been rising very rapidly with these bottlenecks in the transportation system driving up the delivered price of coal, my sense is that the difference in the south, for example, is around 10% or so. That's a big change because the cost difference, taking into account the substantial environmental benefits of gas, is not that huge.

What about rising concern about over-dependence on foreign supply? Won't that keep China focused on coal?
Well, there are enormous costs of continuing down the track of using as much coal as is used now and expanding that in the future and those costs are measured notably in health effects. The idea of maintaining security by burning coal can be a costly one. It's through the lens of security that the West-East pipeline should be understood. It is the anchor for long-distance gas transmission inside the Chinese market. With that anchor, which links up many of the indigenous gas resources in China with the major markets, Beijing and Shanghai in particular, it will be easier to import gas because China will have multiple sources of gas, and so I think security concerns should be ameliorated by that. When they build an LNG reception facility in Shanghai, they don't need to be as concerned about a possible interruption of the supply of LNG if they have an additional source of Chinese gas.

But the big news in the world gas markets is that the number of interruptions of gas supplies is extremely few and the number of interruptions in LNG supplies is essentially zero. Importing LNG probably buys more security than would seem otherwise because it's now a global market with a large number of suppliers, and China has very carefully chosen suppliers that are outside the Middle East.

I think it's inevitable that a large amount of the world's LNG supply is going to come from the Middle East as well, notably Qatar, Iran and Saudi Arabia. All three countries have very large gas reserves. That is inevitably going to raise some of the same concerns we've seen in the world oil markets. But my own view is that those concerns about security have been dramatically overstated. The availability of a world LNG market and the fungibility of supplies create security in a way that was not present when the number of LNG suppliers was small.

Could an energy glut in China dampen interest in gas development?
I've heard a lot of discussion about the possibility of a glut. We're just coming out of a period of glut. But I think the big issue about a possible glut has less to do with the implications for environmentally beneficial fuels and more to do with the implications for investors. As an investor you have to worry about which power plant is going to be cut back. Will the cutback occur across the board or will some power plants be more favored than others? That's what I would be worried about rather than whether I had a fuel that was a little more expensive or less expensive than the alternative. What I hear is that there is a strong commitment from the Chinese government and the relevant provincial governments for the introduction of natural gas so I don't see natural gas power plants being necessarily disadvantaged in a glut.

But if a truly competitive market existed, a glut could be a disaster for gas, as we saw in Brazil, for example, where gas plants didn't get dispatched because the alternative suppliers had lower marginal costs. So I think state control over the system could be quite advantageous to natural gas, assuring investors their plants will get dispatched.

Otherwise people just go back to coal, and gas-fired electricity isn't sold?
They'll go for whatever is cheapest. That's always the risk when you're building a gas facility, which has relatively high operating costs but low capital costs. What you're really worried about is the possibility there will be a long period when there are lots of other power plants with low operating costs that will be in surplus, particularly coal plants, hydro plants, nuclear facilities which have low operating costs so they typically get dispatched first over gas.

But because electricity is virtually impossible to store, you have to build the power system to meet peak demand. This is where gas has an enormous advantage over almost all of the alternatives because it is a very cost effective way to deliver peak electricity and it can be a very cost-effective way to supply base-load [round the clock] electricity. This I think will be a key question for the Chinese power sector. Will new arrangements be established to create an incentive to build the needed peak capacity? With those incentives in place, the advantage for gas is going to grow quite sharply. I see gas displacing coal at the margin.

Now there also are parts of China that are planning ambitious nuclear programs, Guangdong particularly. Even if that is more expensive, the government will pursue that for reasons of energy security because that's a source of electricity that they will be able to control directly. This is potentially very important news in world electricity markets – that not only do we see the rise of natural gas, and that's a durable trend that's been going on for almost two decades, but we also seeing a new pulse of building nuclear reactors.

Where will gas be relative to China's other energy sources, say, 10 years from now?
Right now gas accounts for a tiny fraction. I think it's going to be significantly higher, but the time horizon in the energy business, particularly gas and electricity, is 10 to 15 years and beyond. The real news is not going to be over the next 10 years when we will see a rapid rise of gas, no question but the effect of that. What that growth will do is lock in place a set of infrastructures that will make the role of gas in the overall China economy much larger in the longer term, 20 or 25 years down the road.